Presently, there are a multitude of occupations in which workers can earn up to $50,000 or more annually but pay very low taxes. These types of occupations are generally in “cash businesses”. Cash businesses are those in which only cash is accepted as payment or is generally accepted as payment for goods and/or services. Some examples of cash businesses include, but are not limited to: restaurants, bars, taxi services, cleaning and maintenance services, landscaping, construction/handyman, and the like.
In many cash businesses, there is a widespread practice of underreporting your tips or income. The IRS can use a “reasonable estimate” of tips received by employees to calculate a restaurant's share of FICA taxes, per the Supreme Court's 2002 decision on US vs. Fior D'Italia. The IRS's interest in unearthing these tax liabilities is clear. Billions of dollars in tips go unreported each year. The 7.65 percent employer tax (6.2% social security and 1.45% medicare withholding tax) on those billions is a large amount of money that the IRS is unable to collect.
Presently, cash businesses like restaurants allow waiters and other tipped employees to report gratuities monthly. But restaurants run the risk of having the IRS forcibly estimate waiters' cash tips based on the credit-card tipping rates. Waiters may feel compelled to report more tips, so that their own tax returns don't conflict with their employers'. Alternatively, restaurants can institute a more rigorous system of tip reporting, and perhaps enter into an agreement with the IRS that will reduce the likelihood the establishment will be audited.
Restaurants in some states have signed tip agreements with the IRS. These include, for example, eateries belonging to the Illinois and Nevada affiliates of the National Restaurant Association, a trade group in Washington, D.C. In Illinois, for example, the staff at the end of the night gets a printout of all their checks and the employees have to write in a tip for each printout. The IRS may question the restaurant if reported tips amount to only 5 percent or 10 percent of total receipts. So the restaurants, in turn, hold their waiters' feet to the fire and create a paper trail to back up the calculation of employer-side FICA tax. In Nevada, casinos have had tip rate determination agreements with the IRS for many years. In these agreements, the establishments accept IRS estimates of tips, and in exchange, the IRS says it won't audit the establishments or their workers.
While the above methods help to encourage accurate tax reporting on tips and/or income from sole proprietors and employees of cash businesses, billions of dollars still go unreported each year. Presently, there is not a system in, place that encourages sole proprietors and employees of cash businesses to accurately report their tips/income.
Therefore, a need exists to provide a method to overcome the above problem. The tax reporting method would encourage sole proprietors and employees of cash businesses to accurately report their tips/income.